After slowing in 2012, global growth is projected to pick up during 2013–14, supported by policy actions in advanced economies that have helped mitigate downside risks. The global economy is expanding at three different speeds, with the emerging economies growing rapidly, activity in the United States gaining momentum, and Europe continuing to lag as it struggles with balance sheet repair. In this context, external financing conditions are expected to remain easy and commodity prices near their current high levels in the coming years. However, these conditions could reverse over the medium term, including if advanced economies do not decisively deal with unsustainable debt dynamics or if growth falters in key emerging economies.
Global Backdrop: Receding Risks, Three-Speed Recovery
Global growth slowed to 3.2 percent in 2012 (from about 4 percent in 2011), as policy uncertainties in key advanced economies weighed heavily on activity and trade. The slowdown was widespread, although particularly sharp in Europe, where the combination of sovereign and financial sector strains took a toll on domestic demand. Emerging economies were also affected by weaker demand from advanced economies, although domestic policy tightening and uncertainties also contributed to the slowdown.
Policy actions since mid-2012 have helped defuse the immediate threats to the global recovery, prompting a broad rally in financial markets (Figure 1.1). In Europe, decisive policy actions have increased confidence in the viability of the Economic and Monetary Union.1 Meanwhile, U.S. policymakers averted a large fiscal contraction (“fiscal cliff”) in January 2013, but allowed the automatic across-the-board spending cuts (“sequester”) to take place in March, and have so far agreed only on a temporary solution for raising the federal debt ceiling. The recent recovery in financial markets has helped to improve global funding conditions and support confidence. Activity in emerging economies is regaining strength and commodity prices have firmed up since the middle of last year.2 However, recent activity indicators in advanced economies continue to disappoint, particularly in Europe where credit continues to contract despite reduced sovereign spreads and improved bank liquidity.
Near-term risks have receded since mid-2012, leading to lower sovereign spreads and a moderate recovery in equities and some commodity prices.
Sources: Haver Analytics; IMF, Primary Commodity Price System; and IMF staff calculations.1 Dotted line represents mid-June 2012.2 Simple average for countries in each group.As described in detail in the IMF’s World Economic Outlook for April 2013, global growth is set to recover only gradually in 2013–14 (Figure 1.2). World output growth is expected to reach about 3¼ percent in 2013 and 4 percent in 2014, roughly ½ percentage point below that projected six months ago. The global expansion will take place at multiple speeds. Emerging economies will continue to lead the expansion, growth in the United States is expected to gain momentum, and the recovery in Europe will be constrained by balance sheet repair. Global growth is expected to stabilize to about 4½ percent over the medium term, about ½ percentage below the average growth observed in the five years (2003–07) prior to the Great Recession.
Global growth and trade is projected to pick up in 2013–14. External financing conditions are to remain easy, as advanced economies repair their balance sheets, and commodity prices will remain high.
In advanced economies, growth is projected to strengthen over the coming years (with some heterogeneity), provided policymakers avoid setbacks and deliver on their commitments. After a weak first quarter in many advanced economies, output growth is projected to rise to 2 percent for the rest of 2013 and to average 2¼ percent in 2014. Monetary policy will remain highly accommodative for some time, while household, financial, and public sector balance sheet repair proceeds.
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After contracting in 2012–13, the euro area is projected to expand by 1 percent by 2014. The expected pickup in growth in the second half of 2013 would be underpinned by further improvements in financing conditions, and a smaller drag from fiscal consolidation. The recovery will continue to be much slower in the periphery, where balance sheet problems are more challenging.
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In the United States, annual average growth is projected to slow down this year after a strong 2013:Q1, given budget sequestration that went into effect in March, but underlying growth should accelerate in the second half of 2013 on the back of continued recovery in private demand (see below).
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Growth in Japan is expected to reach 1½ percent in 2013, supported by a large fiscal stimulus package and further monetary easing. The weakening of the yen is also expected to support exports.
In emerging economies, growth is projected to rise to about 5½ percent in 2013, from 4¾ percent in the first half of 2012. The expected recovery in demand from advanced economies continued favorable external financing conditions, and the lagged impact of policy easing adopted in many countries in the second half of 2012 will be the main drivers of growth. The expansion will continue to be led by emerging Asia, and in particular China, where growth is expected to rise to 8½ percent in 2014. Growth over the medium term is expected to hover near 6 percent for emerging economies as a whole—well below the 7½ percent growth rates observed in the years preceding the Great Recession.
In this scenario, commodity prices are projected to remain relatively high, underpinned by strong growth in emerging Asia. Although the overall commodity price index is down 13 percent since peaking in April 2011, prices will remain elevated compared with historical levels, and futures prices suggest they will remain near or slightly below current levels as supply conditions improve. Over the next year, energy prices are expected to fall by 3 percent on increased non-OPEC oil production (particularly in North America); food prices are expected to soften somewhat as supply constraints are alleviated, while metals are expected to remain near current levels. Although tight inventories and strong demand from China provide some near-term upside risks to commodity prices, a sharp reversal in prices cannot be discarded over the medium term, especially if global growth slows sharply (see below).
Compared to mid-2012, near-term risks to the global outlook have receded, although they remain tilted to the downside. 3 Key near-term risks remain centered in Europe, where fatigue in repairing sovereign and bank balance sheets could drive up lending rates and compromise the projected recovery. Renewed financial market volatility in the wake of Italy’s election and recent events in Cyprus demonstrate how vulnerable conditions are to shifts in sentiment. Domestic risks are more balanced in the case of the United States, where growth could surprise on the upside should private demand growth accelerate on the back of a stronger-than-anticipated recovery in the housing market.
Risks are high over the medium term. Lack of decisive actions to put public finances on a sustainable path in key advanced economies could trigger a generalized increase in sovereign and corporate risk premiums, with large spillovers on confidence and global activity. Sharply lower growth in emerging economies, resulting for example from a sudden decline in private investment, could slow down growth and hit commodity prices. Meanwhile, setbacks in addressing sovereign and financial balance sheets in Europe and difficulties in unwinding unconventional monetary policy in advanced economies remain medium-term risks.4
The United States: Modest Growth, Bright Spots Appearing
The economic recovery is proceeding in the United States, fueled by the rebound of the housing market and easier financial conditions. However, the automatic spending cuts that began in March will be a drag on growth. Durable solutions to pending fiscal risks are urgently needed.
Growth in the United States remained tepid at 2.2 percent during 2012 (Figure 1.3). This reflected significant legacy effects from the financial crisis, continued fiscal consolidation, a weak external environment, and temporary shocks, including the severe drought that affected farm activity and inventories and disruptions in the northeast following Hurricane Sandy. Policy uncertainty ahead of the fiscal cliff may also have had some influence. Nonetheless, the recovery is beginning to show some bright spots. Credit growth has picked up, and bank lending conditions have eased slowly from tight levels. Construction activity continued to rebound during 2012, albeit from low levels, and house prices have begun to rise. In addition, the pace of job creation accelerated in the second half of 2012, bringing the unemployment rate below 8 percent for the first time since early 2009. Wage growth has remained subdued, helping to keep inflation pressures well in check.
A gradual U.S. recovery is underway, with demand underpinned by improvements in housing and labor markets.
Despite these favorable trends and generally positive data releases in the first quarter of this year, average U.S. growth will likely slow down in 2013, mainly because of the stronger pace of fiscal consolidation associated with the budget “sequester.” Assuming the spending cuts are sustained for the remainder of the current fiscal year (but are replaced with backloaded measures during the next fiscal year, which begins in October), average growth is projected to fall to 1.9 percent in 2013. Although the tighter fiscal stance will be a major drag on growth, the favorable momentum in the housing market is expected to continue to sustain the recovery, with residential investment continuing its ascent toward levels consistent with trend household formation, and stronger house prices improving households’ balance sheets (Box 1.1). Personal consumption expenditures will be supported by continued, though moderate, job gains and low borrowing costs. At the same time, continued favorable financial conditions, strong profitability, and reduced policy uncertainty are likely to support business investment. As the fiscal drag lessens, these factors are expected to increase growth to 3 percent, on average, in 2014. On the external front, the current account deficit is projected to remain broadly stable at about 3 percent of GDP next year, in part improved by booming unconventional energy production.
Non-energy goods imports are expected to grow by 6 percent next year. The risks to the U.S. outlook have become more balanced since the October 2012 World Economic Outlook:
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On the external front, the main risk remains a worsening of the euro area debt situation, which would affect the United States through both trade and financial channels, including higher risk aversion and a stronger U.S. dollar. A more benign scenario of prolonged euro area stagnation (analyzed in detail in the April 2013 World Economic Outlook) would reduce U.S. output by about ¼ percentage point over two years.
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On the domestic front, although the passage in January of the American Taxpayer Relief Act (ATRA) largely eliminated the threat of the “fiscal cliff,” durable solutions to other fiscal issues are still needed. Failure to replace the across-the-board spending cuts (“sequester”) with other backloaded measures before October would imply a larger drag on growth in late 2013 and beyond. Many important programs in education, science, and infrastructure would face deep cuts, undermining future growth. At the same time, the key drivers of long-term spending pressures (public health care, public pensions) would remain largely unaffected.
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Another risk is a rise in the U.S. sovereign risk premium, prompted by further entanglements over raising the debt ceiling (which has been suspended only temporarily until May) or failure to make progress on medium-term consolidation plans. Simulations presented in Chapter 1 of the April 2013 World Economic Outlook suggest that a rise in 200 basis points in Treasury bond yields could lower U.S. growth by 1½ to 2½ percentage points during the first two years, with substantial negative spillovers to the rest of the world. On the upside, a prompt resolution of the remaining uncertainty over fiscal policy could boost sentiment and lead to a faster recovery.
Developing a medium-term fiscal deficit reduction framework remains the top policy priority in the United States. Despite progress made so far through discretionary spending caps and modest tax increases, a comprehensive plan that includes entitlement reform and new revenue-raising measures is needed to place public debt on a sustainable footing in the long run. Within the contours of such a plan, fiscal consolidation should proceed gradually in the short run, in light of the fragile recovery and very limited room for monetary policy offset (Figure 1.4).
Monetary policy remains accommodative, while gradual fiscal consolidation proceeds. The threat of a large fiscal contraction has been defused.
With the sizeable output gap expected to keep inflation below 2 percent during 2013–14, and given the downside risks still surrounding the recovery, the additional policy easing announced by the U.S. Federal Reserve in December 2012 seems appropriate. Moreover, increased transparency regarding future monetary policy decisions—which now links the timing of the first increase in the policy rate to specific thresholds—should provide further clarity to market participants. The IMF staff growth projections are consistent with a first policy rate hike by the Fed in early 2016. In addition, as the labor market returns to more normal conditions, the pace at which the large asset position of the U.S. Federal Reserve will be unwound will require careful design to avoid unwarranted financial volatility.
Further progress in implementing the Dodd-Frank Act remains critical for improving the resilience of the U.S. financial system. U.S. banks have strong capital ratios and the results of the stress tests published in March 2013 were reassuring. However, pending tasks include completing the designation of systemically important institutions, strengthening the regulation of money market mutual funds, reducing the systemic risk in the tri-party repo market, carefully implementing the Volcker Rule, and progressing with Basel III implementation.
Canada: Moderating Growth Amid Currency Strength
After losing steam in 2012, the Canadian economy is set to recover gradually during the course of this year. Policies should be geared to support the recovery, while remaining vigilant to risks arising from high levels of household debt.
The Canadian economy lost momentum in 2012. The economy rebounded strongly in 2010–11, thanks to effective policy action, a resilient financial sector, and high commodity prices. In 2012, however, growth slowed to below 2 percent, reflecting a weakening in external conditions and a more subdued domestic demand (Figure 1.5).
Canadian growth has been constrained by tepid U.S. recovery and gradual fiscal consolidation. Housing sector vulnerabilities have diminished, but persist.
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Fiscal policy has continued to be a drag on growth, as the federal and a majority of provincial governments implement plans to return to balanced budgets. The general government cyclically adjusted fiscal deficit fell by an estimated 1¾ percentage points between 2010 and 2012, mainly reflecting spending cuts. These headwinds from fiscal policy were partially offset by highly accommodative financial conditions, with the Bank of Canada maintaining the policy rate at 1 percent amid subdued inflationary pressures.
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Private consumption weakened on the back of sluggish disposable income growth and weak consumer credit, as record-high household debt levels induced more caution in borrowing and a tightening in the access to home equity lines of credit. The housing sector cooled off during the second half of 2012, especially in the large metropolitan areas of Toronto and Vancouver, with home sales and construction activity moderating. Temporary disruptions in the energy sector and uncertainties about the global outlook also weighed on business investment.
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A softening in external demand and a strengthening of the currency, boosted by safe haven-induced capital inflows, put pressure on exports and led to a further deterioration in the current account (see Box 1.2 for Canadian export performance to the United States).
Economic growth is expected to pick up in the second half of 2013, accelerating to about 2½ percent by 2014–15, a pace consistent with a gradual closure of the output gap and convergence of unemployment to its natural rate.
Business investment and net exports are expected to benefit from the projected strengthening of the U.S. economy and the waning impact of the temporary disruptions in the energy sector, while high household debt and continued moderation of the housing sector are likely to weigh on private consumption and residential construction. Fiscal consolidation will continue to weigh on growth, with financial conditions remaining very accommodative through much of 2013.
Risks around the baseline scenario remain tilted to the downside, in particular from a stronger than anticipated fiscal drag in the United States, further turbulence from Europe, and a decline in global commodity prices. On the domestic front, a more abrupt unwinding of domestic imbalances than currently envisaged in the forecasts cannot be discarded.
The main challenge for Canada’s policymakers is to support growth in the short term while reducing the vulnerabilities that may arise from external shocks and domestic imbalances. The current monetary policy stance is appropriately accommodative, given the negative output gap, and well-anchored inflation expectations. Under staff’s baseline scenario, a gradual tightening of monetary policy should begin in late 2013, when growth is expected to gain momentum. Although Canada’s fiscal position is stronger than many other advanced economies, removing the fiscal stimulus and returning to a balanced budget is important to rebuild fiscal buffers against future adverse shocks and contain appreciation pressures. That said, the pace of consolidation should remain attuned to the strength of the economy and automatic stabilizers should be allowed to operate fully, if growth were to weaken further.
The high level of household debt makes the Canadian economy more vulnerable to adverse external shocks. Although the macroprudential measures adopted during 2011–12 have helped to moderate the growth in mortgage credit and the housing sector, more measures may be needed if the ratio of household debt-to-disposable-income continues to rise.
U.S. Household Balance Sheets After Five Years of Repair
One of the key forces underlying sluggish growth in the United States has been the drawn-out process of household balance sheet repair. In the aftermath of the Great Recession, balance sheets were weakened by the bursting of the housing bubble and lower stock prices—household net worth fell sharply from 650 percent of disposable income (DI) in 2006:Q1 to 480 percent in 2009:Q1. The American households were also over-indebted at the onset of the crisis, with the debt-to-income ratio peaking at around 135 percent of DI in 2007:Q3 compared with the roughly 100 percent debt ratios observed in the early 2000s. Low net worth and over-indebtedness led consumers to boost their savings, putting a drag on private consumption and—more broadly—the pace of economic recovery.
United States: Net Worth
(Percent of disposable income)
Sources: Haver Analytics; and IMF staff calculations.Substantial progress has been made to improve household finances in recent years, but the progress has been uneven.
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Household net worth recovered to 543 percent of disposable income, close to the long-term average and optimal wealth holdings (Carroll, Slacalek, Sommer, 2012). However, much of the recovery in asset values has been driven by higher stock market wealth that tends to boost private consumption to a smaller degree than housing wealth, which remains depressed.
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Aggregate debt has been reduced to about 110 percent of DI. During the severe financial crises in the Nordic economies during the 1980s/1990s, the household leverage eventually came down to the pre-bubble levels—the United States has followed a similar trend so far. Non-mortgage consumer credit growth has picked up (partly reflecting a boom in the student loans sector), but credit conditions remain tight and ease only slowly in the crucial mortgage market.
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The microeconomic evidence provides a cautionary tale. Since about two-thirds of the decline in aggregate household debt reflects households shedding debt through defaults, these households may not be able to borrow when the economic prospects improve, which would moderate the recovery. In addition, households which had precarious balance sheets before the crisis appear to have made limited progress in rebuilding net worth through active savings out of income (Celasun, Cooper, Dagher, and Giri, 2012). In the absence of rapid house price appreciation and income gains, these households could choose to save more in the future.
United States: Household Assets
(Percent of disposable income)
Sources: Haver Analytics; and IMF staff calculations.Household Debt: U.S. now vs. Nordics in 1980s/90s
(Percent of disposable income; pre-crisis peak at t = 0)
Sources: OECD; Norges Bank; Statistics Finland; Riksbank; and IMF staff calculations.1 The years in parentheses correspond to the peak in the household debt ratio.Overall, household spending will likely remain sluggish in the near term; although consumption could gradually pick up during 2013–14 once the recent tax increases are absorbed by consumers. With the U.S. stock prices close to 5-year highs, measures to further facilitate housing market adjustment would seem an important tool to buttress household balance sheets. Such measures could include participation by the U.S. government-sponsored entities (Fannie Mae, Freddie Mac) in principal writedowns, an expansion of the existing mortgage refinancing and rental programs, and changes in the legal framework governing mortgage bankruptcies (IMF, 2012a and 2012b).
Note: This box was prepared by Martin Sommer.Canadian and Mexican Exports to the United States: A Tale of Two Countries
The fortunes of Canadian and Mexican exporters have changed significantly over the past two decades.
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During the 1990s, both Canada’s and Mexico’s exports benefited from robust U.S. demand and trade agreements (CUFTA and NAFTA). Over this decade, Canada became the largest exporter to the United States (representing almost 20 percent of all U.S. non-oil goods imports), while Mexico’s share of U.S. non-oil imports almost doubled (to about 9 percent).
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The 2000s were less favorable for exports from NAFTA partners. Sharply lower U.S. demand hurt both Canada and Mexico—U.S. annual non-oil import growth fell from an average of about 11 percent in the 1990s to 3 percent in the 2000s—at a time when competition from China intensified following its entry in the World Trade Organization in 2001. Canada’s non-oil goods exports as a share of GDP fell by 12 percentage points between 2001 and 2011—mainly owing to lower manufacturing export volumes—and China surpassed Canada as the United States’ largest trading partner. Meanwhile, Mexico’s non-oil export growth slowed significantly from an annual average of 16 percent during 1991–2000 to about 3 percent during 2001–11.
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Exports from both countries to the United States have recovered since the Great Recession, yet at a markedly different pace. Although Canada’s non-oil export volumes remain below pre-crisis levels, Mexico’s non-oil exports have reached new highs, consolidating Mexico’s position as the United States’ third largest trading partner (13 percent of all U.S. non-oil imports come from Mexico).
U.S. Non-Oil Import Shares by Country
(Percent)
Sources: Haver Analytics; and IMF staff calculations.Real Exchange Rates and Total Terms of Trade
(Index, 2000=100)
Sources: Bank of Canada; Haver Analytics; and IMF staff calculations.Canada’s loss in external competitiveness over the last decade reflects stiff competition from China, amid strong currency appreciation and relatively low productivity growth. Canada’s share of U.S. non-oil goods imports fell by over 6 percentage points since 1999, driven by declines in manufacturing (7 percentage points). Estimates by Medas and Dai (2012) suggest that the large real appreciation (38 percent between 2000 and 2011), largely driven by the surge in commodity prices, may explain close to two-thirds of Canada’s loss in the U.S. manufacturing import market share. Increased competition from China and relatively weak productivity in the manufacturing sector further undermined its ability to adjust to the stronger currency.1
Real Dollar Annual Wages: Mexico and China
(In 2011 thousands of US dollars)
Sources: Barclays Capital; and CEIC China Database.Mexico has been able to better withstand competition from China. In the first half of the 2000s, Mexican firms saw their overall share of U.S. non-oil imports fall by close to 1 percentage point. However, Mexico’s market share rebounded and reached new highs in 2012, mainly driven by robust gains in manufacturing exports (up over 2 percentage points since 2005). These gains were predominantly due to Mexico’s improved ability to compete with Chinese firms (see Kamil and Zook, 2012), amid increased productivity (resulting in part from structural reforms in the areas of trade and property rights). In addition, increased transportation costs and strong wage growth have eroded China’s cost-advantage. Furthermore, and unlike Canada, Mexico’s currency has depreciated over the last decade (falling by about 10 percent in real effective terms since 2000), providing another boost to exports.
Note: This box was prepared by Paulo Medas. 1 In spite of this, the flexible exchange rate has served Canada well, especially by buffering against adverse external shocks.European actions include the Outright Monetary Transactions, completion of the European Stability Mechanism, renewed agreement on Greece’s adjustment program, and agreement on the Single Supervisory Mechanism.
As of March 2013, commodity prices were up about 8 percent from June 2012, reflecting stronger external demand and supply constraints in some cases (weather-related shocks in the case of cereal prices, and OPEC production cuts in the case of energy).
Near-term risks related to oil supply shocks and geopolitical factors remain unchanged, whereas those related to a hard landing in emerging economies have diminished.
